6 Cyclical Stocks That Are Overbought

What a difference a year makes. Whereas the first quarter of 2009 was a bloodletting -- the S&P 500 hit its crisis low on March 9 -- stocks just turned in their best first quarter since 1998. But don't let that rosy statistic lull you into complacency; there is no shortage of reasons for investors to remain extremely vigilant right now.

Sectors: Winners and losers
Let's take a look at the best and worst-performing sectors in the S&P 500 for the year through April 1:

Top 3 S&P Sectors

Year-to-Date Return*

Industrials

12.5%

Financials

10.9%

Consumer Discretionary

10.1%

Bottom 3 S&P Sectors

 

Energy

1.1%

Utilities

(3.4%)

Telecom Services

(4.8%)

Source: Standard & Poor's.

That two of the three best-performing sectors were cyclical (industrials, consumer discretionary) and two of the three worst-performing sectors were defensive (utilities, telecoms) is consistent with -- and reinforces -- the notions that the economy has exited recession (true) and is now in a conventional recovery (false). (Similarly, small- and micro-cap stocks also outperformed the broad market in the first quarter, with gains of 8.9% and 9.9%, respectively).

Don't overpay to bet on a recovery
Even if you believe we are in a conventional recovery, that is no justification for overpaying for cyclical stocks. As I mentioned last week, according to David Rosenberg, head strategist at asset manager Gluskin Sheff, cyclical stocks are pricing in levels of economic activity that are well ahead of current trends. Here are seven stocks -- six of which are cyclical -- that look like they may be overbought and overvalued:

 

Year-to-Date Return

Price-to-Earnings*

Ford Motor (NYSE: F  )

36%

9.0

Whole Foods Market (Nasdaq: WFMI  )

32%

26.9

Wynn Resorts (NYSE: WYNN  )

32%

73.6

Abercrombie & Fitch (NYSE: ANF  )

28%

19.4

Akamai Technologies (Nasdaq: AKAM  )

25%

22.7

JDSU Uniphase (Nasdaq: JDSU  )

45%

25.7

priceline.com (Nasdaq: PCLN  )

17%

19.5

*Based on next fiscal year's earnings.
Source: Capital IQ, a division of Standard & Poor's as of April 6, 2010.

Two separate, sensible strategies
The two most reliable indicators of value, the cyclically adjusted P/E ratio and Tobin's q ratio, both suggest U.S. stocks are overvalued. In that context, sensible investors can follow one of two strategies: Index/asset allocation-oriented investors should underweight U.S. stocks; meanwhile, investors who prefer to own individual stocks should ensure that those stocks are no more than fairly valued.

Between high valuations and slow growth, investors should expect disappointing returns from U.S. stocks over the next several years. Tim Hanson explains how to make more in 2010.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Akamai Technologies is a Motley Fool Rule Breakers choice. Ford Motor, priceline.com, and Whole Foods Market are Motley Fool Stock Advisor selections. Try any of our Foolish newsletters today, free for 30 days. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (8) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 07, 2010, at 4:16 PM, wigginsrl wrote:

    I don't get what you're saying. How can Ford, with a forward P/E of 9, be overvalued?

  • Report this Comment On April 07, 2010, at 5:40 PM, TMFAleph1 wrote:

    Ford may not be overvalued; however, despite the fact that a P/E of 9 appears cheap on an absolute basis, it falls within the upper third of the range of multiples for companies within its primary sector.

    Personally, I'm not sure any margin of safety is too large to own a US auto -- at a P/E of 9, I wouldn't even consider it. The big 3 have consistently destroyed shareholder wealth over the past few decades. It would take some sort of revolutionary transformation for me to look at these stocks.

  • Report this Comment On April 07, 2010, at 7:29 PM, Varchild2008 wrote:

    Just curious as the article appeared minutes before the closing bell today. The headline acts as a "SPOOK" effect to any newcomer investor who wants to pick his/her first stock for his/her portfolio.

    They come in the market around 3:50 p.m. 10 minutes before the bell to make their purchase only to see your article appear at 3:48p.m. hmm?

    Be Contrarian..fine...but maybe save it for AFTER the closing bell? Rather than have a FLASH FLASH "I think FORD is overpriced!!!"

    Especially since this contrarian opinion flies right in the face of sensational month to month to month earnings this past quarter....

    You are listing a stock..here...that would require an entire article devoted to it in order to have a well thought out contrarian opinion. Lumping it in like this just acts as nothing more than a means to try to knock a share price down for whatever your reasons are for that.

  • Report this Comment On April 07, 2010, at 7:54 PM, baldheadeddork wrote:

    Pardon our confusion, because when you wrote "here are seven stocks that appear to be overbought _and_ overvalued", it did give the impression that you thought F was overvalued.

    Stuff like this is why I think data without context about the company and its industry looking forward is a really crappy way to invest. If you're going off the big three destroying wealth for last "few decades" (another incorrect generalization, but never mind) you wouldn't go near any industrial stock, but the management and market position of Ford today has not a damn thing to do with how the company was run between 1970 and 2000.

    How much wealth was destroyed in the tech sector in the last decade? Do you think that makes Apple, Google Amazon or Microsoft as toxic today as your painting Ford out to be? (Yes, all of those are more profitable and have better debt positions, but when was the last time you saw any of those four with a P/E of 9?)

    The strongest company in an industry with weak or damaged competitors typically outperforms its industry and the market, and that's what F is doing now.

    Forgive me for being so harsh, but I expect better analysis of any industry from a CFA.

  • Report this Comment On April 07, 2010, at 8:46 PM, TMFAleph1 wrote:

    I don't know about Google, Amazon, Apple or Microsoft, but eBay was trading at less than 12 times earnings estimated 2009 EPS when I singled it out in the following article:

    Roundtable: Google, Amazon, or Apple?

    The Motley Fool, Jul. 9, 2009

    http://www.fool.com/investing/general/2009/07/09/roundtable-...

  • Report this Comment On April 07, 2010, at 9:03 PM, TMFAleph1 wrote:

    baldheadeddork,

    Thanks for your follow-up comment. In most of my articles, I'm reasoning on a statistical basis, so it's far from inconceivable that I might be wrong on a given name. My goal isn't to produce definitive 'buy' or 'sell' recommendations; I try to provide some guidelines according to which investors can think about the stocks they own or wish to buy.

    P.S. Hasn't the US auto industry, in aggregate, been a destroyer of shareholder wealth over the past few decades? I'd be very interested if you have any data that falsifies that statement.

  • Report this Comment On April 14, 2010, at 11:04 AM, baldheadeddork wrote:

    Alex, sorry for not replying earlier. My wife had some minor foot surgery last week and I've been doing my best impression of a butler since.

    With all respect, I think you're trying to backpedal from what was in the story a straightforward declaration. If what you wrote wasn't a definitive sell/not buy recommendation on Ford, it damn well looked like one.

    If the US auto industry in aggregate has destroyed wealth is irrelevant to your recommendation on any one stock or the outlook for any one company. The analogy to the tech meltdown and dot com bubble at the beginning of the last decade stands. The idiocy of Flooze, WebVan and Pets.com doesn't mean that Google, Apple or even Amazon are by association "destroyers of shareholder wealth". There is something incredibly shallow about declaring that every company in a sector is toxic today because of the performance decades ago.

    And that gets to your last point. Has the US auto industry, in aggregate, been a destroyer of wealth over the last few decades? Unless your definition of "few decades" is the last five to ten years, the answer is a definitive no.

    Going back a few decades would take us back to the beginning of the sixties. Go look at the charts. US auto stocks have rarely been good value investments, but they have historically kept pace with the broader market and the industry (including non-US automakers) traditionally pays a healthy dividend.

    Since it's central to this conversation I'll use Ford as an example. Yahoo Finance's online records only go back to 1977, which was already past the era when US automakers owned the industry. Yet the adjusted share price (including splits and dividends) from the beginning of 1977 was 50 cents a share. If you had invested $10,000 in Ford then and held for the next 33 years, your investment today would be worth $261,000. That means an investment in F outperformed inflation over the same period by 7.45:1. Call that what you want, but it's not destroying shareholder wealth by any definition.

  • Report this Comment On June 06, 2010, at 6:21 PM, MegaEurope wrote:

    Alex, what do you mean by cyclical? Revenues and earnings at WFMI, AKAM and PCLN did quite well during the downturn, so I would classify them as non-cyclical. F, ANF and JDSU on the other hand clearly suffered, with WYNN being in between.

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